Using Bond Funds as Part of Total Return Investing

[DawgMan]

I am a Total Return investor, or at least tell myself I am. I float around a 60/40 AA allowing myself +/- 5% leeway before I think about a rebalance and suspect I will stay in this range/approach thru retirement. It took me a while, but I finally made peace with the fact I should look at my bond allocation as a ballast, with less focus on the yield. That said, I still have a small "fight for yield" habit I am trying to kick. Today, my 40% bond allocation is roughly 64% Intermediate Core, 21% Short Term Treasuries, and 15% Preferred Stocks, all in funds/ETFs. Despite all the chatter (external and internal) saying get out of bonds, they have no place to go but down, I have stayed the course. Interestingly, my YTD Total Returns are in the 5% - 7%, 3%+, and 5%+ ranges respectively. This makes me feel good, I guess, but I have to say I really don't fully understand why they have performed like they did this year when interest rates have stayed low and money has been pumping into the stock market. So as we approach year end and I begin to plan for my AA adjustments, maybe you can help me with these questions...

- What is the "right" mix and strategy using short/medium/long term bond funds in this environment, particularly if you are not relying on only yield to fund your retirement?

- What events dictate a change in your bond mix such as moving more money into long term bonds/moving more money into short term/staying all in intermediate bonds? What tell signs do you rely on to make any real moves here (Fed strategy, inflation, government policy, momentum of bull/bear markets)?

- Should i give up my Preferred stock habit and go clean?

For the most part, I have subscribed to Bogle's motto "Don't do something, just stand there!"

What say you?

 

[njhowie]

- What is the "right" mix and strategy using short/medium/long term bond funds in this environment, particularly if you are not relying on only yield to fund your retirement?

- What events dictate a change in your bond mix such as moving more money into long term bonds/moving more money into short term/staying all in intermediate bonds? What tell signs do you rely on to make any real moves here (Fed strategy, inflation, government policy, momentum of bull/bear markets)?

- Should i give up my Preferred stock habit and go clean?

For the most part, I have subscribed to Bogle's motto "Don't do something, just stand there!"

What say you?

As with any investment, "it depends" on your investment objective and risk tolerance/profile.

What's your view on interest rates? Never thought about it, don't care, or don't want to care? Then just go with short and/or intermediate term bond fund(s).

As for the preferred stocks, again, "it depends" - investment objective and risk tolerance/profile. Ask yourself why you are invested in them? Are you chasing yield? Do you have a genuine interest in the issuing companies? Do you understand the pitfalls of preferred stocks? There's nothing wrong with investing in preferred stocks, but if you cannot clearly justify why you own them, then why should you?

Personally, I am heavily invested in bonds. At this time, when rates are disgustingly low, I opt for quality over yield. After that, I look at the term. When rates are low, I am selling my longer term bonds (as they become overpriced and generate capital gains) and buying shorter term ones (near term maturities allow adjusting sooner when rates go higher).

I don't see anything bad about the way you have your bond allocation allocated. You need to decide for yourself on the preferreds.

 

[Lsbcal]

YTD for VFIUX Intermediate Treasury is about 8.0%. Primarily due to rate declines. How low can it go? The 5 yr Treasury is now 0.39% and the 5 yr TIPS are at -1.28%. Yech!

I think going forward for some years that stock returns will be better. I have decided to take no corporate or credit risk in bond funds and depend on stocks for future better returns. I do retain some old 3.4% yield iBonds and some TIPS maturing 2 years out. So the change is roughly to 20% of our portfolio.

Here is what I wrote on one thread:

FWIW, recently I revised the AA to about 65/35 from 60/40. I did this by exchanging the investment grade bond funds (retirement accounts so no tax consequences) for intermediate treasuries. So the extra risk was taken in stocks and not in bonds. Data from the last 30 years has shown this to give superior returns in up/down bond markets.

Just mentioning this as one approach.

 

[Montecfo]

In my opinion the right mix is short to intermediate. I use core or core+ bond funds and a short term high yield fund (duration 90-120 days). The rest is CDs and MM.

I avoid sovereign debt because in my opinion the opportunity is with credit risk.Others avoid credit and buy treasuries (all rate risk, no credit risk).

All depends on strategy.

Preferred stock is equity, not debt. I carry them in my equity allocation.

 

[pb4uski]

On the first part as to why fixed income has performed so well in 2020 I don't think you need to look any further than the decline in the 10 year Treasury (below).

On the second part... since I went into capital preservation mode earlier this year I'm now viewing my preferreds as just part of my risk-on (albeit admitedly not a lot of risk-on)... and I recently expanded my preferreds from 10% to 20% of my total... and that is as big as I'm willing to go.

So I'm gravitating from ~60/10/30 stocks/preferreds/fixed at the beginning of 2020 to a target of 25/20/55 at the end of 2020. I say target because 21 of the 25 targeted for equities is currently parked in cash so right now I'm really 4/20/76. At this point the 4 in equities is all SWAN.

Most of my 55 in fixed is in 3-3.5% 5-year CDs that I gourged out on in 2019 and 1.35% and 2.25% 1-year CDs that I bought earlier in 2020... all together they yield about 3% so I think of that as decent ballast.

If I was going bonds/bond funds route I would probably be going short and avoiding credit risk as much as possible and the 21 that is parked is in Vanguard Short-Term Federal Fund Admiral Shares.

Of course, YMMV.

 

[DawgMan]

As with any investment, "it depends" on your investment objective and risk tolerance/profile.

What's your view on interest rates? Never thought about it, don't care, or don't want to care? Then just go with short and/or intermediate term bond fund(s).

As for the preferred stocks, again, "it depends" - investment objective and risk tolerance/profile. Ask yourself why you are invested in them? Are you chasing yield? Do you have a geniune interest in the issuing companies? Do you understand the pitfalls of preferred stocks? There's nothing wrong with investing in preferred stocks, but if you cannot clearly justify why you own them, then why should you?

Personally, I am heavily invested in bonds. At this time, when rates are disgustingly low, I opt for quality over yield. After that, I look at the term. When rates are low, I am selling my longer term bonds (as they become overpriced and generate capital gains) and buying shorter term ones (near term maturities allow adjusting sooner when rates go higher).

I don't see anything bad about the way you have your bond allocation allocated. You need to decide for yourself on the preferreds.

Other than my small preferred habit which was designed to chase a little bit of extra yield, my bonds are there as a ballast to minimize some volatility from the equity markets, so less concerned about yield by itself, but more interested in trying to understand the total return drivers. Based on the current climate, I would have thought short term funds might have performed better from a total return perspective, but they haven't so far.

 

[audreyh1]

I ignore yield and focus on higher credit quality that is less correlated with equities. I use short and intermediate bond index funds.

Short term funds often don’t outperform intermediate term funds. Nevertheless I maintain a diversification across maturities with some cash, some short-term bond funds, and mostly intermediate term bond funds.

 

[DawgMan]

On the first part as to why fixed income has performed so well in 2020 I don't think you need to look any further than the decline in the 10 year Treasury (below).

On the second part... since I went into capital preservation mode earlier this year I'm now viewing my preferreds as just part of my risk-on (albeit admitedly not a lot of risk-on)... and I recently expanded my preferreds from 10% to 20% of my total... and that is as big as I'm willing to go.

So I'm gravitating from ~60/10/30 stocks/preferreds/fixed at the beginning of 2020 to a target of 25/20/55 at the end of 2020. I say target because 21 of the 25 targeted for equities is currently parked in cash so right now I'm really 4/20/76.

Most of my 55 in fixed is in 3-3.5% 5-year CDs that I gourged out on in 2019 and 1.35% and 2.25% 1-year CDs that I bought earlier in 2020... all together they yield about 3% so I think of that as decent ballast.

Of course, YMMV.

With a 25% equity allocation target and beefing up your preferreds, should I assume you are focused more on pure yield/dividends as your funding source, as opposed to a total return approach?

While I have thought about moving as low as a 50/50 AA, I feel it is my fiduciary to grow my stash at some reasonable level, whether I find a way to use it all while I am around or just end up giving it away to my kids and charity... it's just my nature I suppose.

 

[pb4uski]

I don't really think so much in total return terms these days with such a low equity allocation.

I look more at how my pension, interest/preferred dividends and SS compare to our spending. Since we are not on SS yet, pension and interest cover about 80% of our target spending... but the reality is that we have spent so little in 2020 that our WR will be about 1%. Once SS starts, our SS and my pension will be ~80% of our target spending and with interest it would be 142% of our target spending.

I am cognizant of the generational issues... we have pretty much told the kids not to plan on anything and that any inheritance is estimating error on my part. That isn't really true but I think it best that they have low expectations.

I will eventually get back into equities if valuations ever seem sensible again, but probably not more than 30-40%... there is no real need to do more than that given our funding.

 

[pb4uski]

.... While I have thought about moving as low as a 50/50 AA, I feel it is my fiduciary to grow my stash at some reasonable level, whether I find a way to use it all while I am around or just end up giving it away to my kids and charity... it's just my nature I suppose.

You made me curious, so I ran FIRECalc with 60/40 AA vs 25/75 AA. Both are 100% success. Max spending at 100% success is 128% of target spending at 25/75 and 133% of target spending at 60/40, so not a huge difference.

As would be expected, terminal values at age 100 are pretty different... all expressed as % of initial portfolio value

AA, low terminal value, high terminal value, average terminal value
25/75, 64%, 574%, 187%
60/40, 100%, 889%, 350%

Sorry kids!